Paytm is returning excess cash before it even has it
Paytm is returning excess cash before it even has it
Or how some investors are more equal than other investors
If you’re the management of a publicly listed company, and you make a nice profit at the end of the year, there’s a couple of things you can do with those profits. You could, of course, invest that money back into your company. That’s how your business would grow, after all. But you could also return some of that cash back to the investors in your company.
Depending on the company, market prospects, competition, past investments, etc., etc, both of these are valid choices and you can make a well-thought out, calculated decision by considering all these factors and speaking to your investors and getting their opinion. The bottom line is that if you have profits and excess cash, you also have the luxury of making a choice about what to do with that money. If your company doesn’t make a profit, there wouldn’t be excess cash to “return” to your investors. You’re surviving off the money they gave you in the first place!
Well, last week, Paytm upended this very simple model I just described above by being an unprofitable company that decided to return money to its investors. They’re planning on giving back up to ₹850 crores ($102 million)1. This is a company that had a net loss of more than ₹2300 crores ($280 million) last year and is on its way to losing even more this year. From the company blog:
Our Board has approved the proposal for buyback of equity shares on Tuesday (December 13, 2022). All directors present voted unanimously in favour of the proposal, including independent directors. We will undertake a buyback of up to ₹850 crores (excluding buyback taxes and other transaction costs) at a maximum price of ₹810 per share, and have opted for the open market through stock exchanges method, which is to be completed within a maximum period of 6 months. Our Board has determined that a buyback of the company’s shares would be accretive for its shareholders, citing strong financial performance, clear path to cash flow generation and excess cash as a result.
Paytm doesn’t have excess cash, its management just sees a “clear path” to excess cash sometime in the future which they feel is a good enough reason to start returning money. Usually it’s a good idea to actually having excess cash before you start returning that cash.
Two buybacks, this is neither
If a company invests a ton in research and development, pays its employees top salaries, ensures it’s a notch above competition, and still ends up with excess cash, returning that money is usually nice. Apple is a great example, it invests billions in research and still ends up with money remaining. Paytm is obviously no Apple.
Alternatively, if a company has genuinely, wholly run out of ideas, if it’s just tired and yet ends up with money every year, returning money is still nice? No point investing it back into the company. IBM is a great example. But Paytm is no IBM either—if anything it’s a company with too many ideas. It began with payments, now it’s got stocks, shopping, movie tickets, bus tickets, loans, and it doesn’t seem to stop!
So why really does Paytm need to go through all this bad PR and announce a buyback? (I’m grateful to have a sweet topic to write about, though. Thanks, VSS.)
Some investors are more equal than other investors
Now that Paytm is a publicly listed company, its responsibility towards all its shareholders (investors) is the same—increase the company’s share price so that all shareholders can benefit equally. Sure, sometimes a company’s investors might disagree with each other and the company will obviously listen to whoever owns a larger stake, but ultimately the benefits will go to all investors.
And yet, we know that a company would probably like some investors more than others. If you were an early venture capital (VC) investor who invested in a company while it was just a baby, you’re bound to have a strong relationship with the founder and management2. The founder probably came to you for advice. You might call them over to give motivational talks to other entrepreneurs. Maybe even retweet each other's tweets. A company is more likely to like them more than its new investors who bought shares after it was all big and fancy.
When Paytm decided to do a buyback, it had two options.
Buy shares from the open market. Whoever sells shares when Paytm is buying gets to sell their shares to the company. This is what Paytm’s going to do.
Run a “tender offer”. Decide on a fixed price. Ask investors interested in selling shares to apply. If there are more shares being sold than Paytm can afford to buy, it has to buy a proportionate number of shares from every investor. It can’t pick and choose which specific investors to buy from.
If you’re a VC investor in Paytm looking to sell your stock, you’d want the buyer to be Paytm itself. Because Paytm would pay more than whatever else any investor would (the whole point of the buyback). But if Paytm ran a tender offer, you might not get to sell any of your shares, and even if you did, it would be a small number at best. If Paytm’s buying shares from the open market, though, you might get “lucky” and sell a lot more than the company’s post-IPO investors.
And “luck” can be manufactured, of course. As a VC investor, you’re buds with the founder. Even the company might like to buy the stock from you instead of from a normie investor. But Paytm can’t pick a particular seller when it’s buying stock from the open market. It’s got to buy from whoever’s selling.
Now, Paytm is a fairly liquid stock. There’s a lot of buying and selling happening constantly. Even if Paytm wants to favour its VCs, it wouldn’t be easy. But it's definitely possible! There are some days when there are just fewer investors trading in the market3. Paytm could turn up in the market right before, say, New Year’s day and dump its entire chunk of ₹850 crores while most regular investors are chilling in Goa or Thailand, and VCs could just happen to be selling at the same time.4
I’m not suggesting that this is what Paytm has in mind. This would require that Paytm communicate with their VCs and tell them exactly when it would buy stock, and that would be insider trading. Which is very illegal! I’m not saying that Paytm plans to do illegal stuff, all I’m saying is that this buyback makes sense only if they do plan to do illegal stuff.
Yesterday, India’s markets regulator SEBI approved its proposal from last month to gradually do away with open-market buybacks entirely5 :
Under the stock exchange route, there is a possibility of one shareholder’s entire trade getting matched with the purchase order placed by the company and thus depriving other shareholders to avail the benefit of buyback. This runs contrary to the underlying principle of equitable treatment which forms the basis of all the corporate actions.
It’s almost as if Paytm read this proposal and rushed to do an open-market buyback while it still had the chance.
Correction: I’d earlier described the tender offer buyback process incorrectly. Every investor doesn’t sell an equal number of shares and shareholders aren’t picked at random like in an IPO. Fixed it now.
An unprofitable company returning its future excess cash to investors is weird. What’s weirder is that Paytm had quite the IPO just last year. It raised ₹18,300 ($2.2 billion), then the largest ever in India! A bit more than half of this went to Paytm’s older investors, and ₹8,300 ($1 billion) to the company to invest in the business.
Obviously VCs can have bitter, bitter conflicts with founders in which case a company’s management would rather not listen to them. This usually never happens for large companies, though, and would much likelier happen during a company’s early days.
I checked the total trade value for Paytm’s stock and even though it is a liquid stock, there is a lot of variance on a day-to-day level. The minimum traded value on NSE in the last 3 months was just about ₹13 crores ($1.5 million) on 24 October, Diwali day. The highest was about ₹3,158 crores ($380 million) on 17 November (the average is about ₹287 crores). If Paytm were to buy shares worth ₹850 crores on a day with low trade volumes, whoever’s selling can get a much higher price for their shares.
Paytm wouldn’t only buy the VC’s shares if this were to happen. But the VCs would get to sell a lot more shares than otherwise this way. Oh also, if Paytm actually started buying up shares on New Year’s Eve it would be extremely suspicious. Usually these things are more subtle.
Additionally, here are two papers that assess whether insiders (such as VCs) benefit from open-market buybacks. Both of them think, yep, they do.